When you set up your company, you hopefully set up a stock option plan (also known as an equity inventive plan) at the same time so that you have a plan that is properly adopted and ready to be used when you are about to grant options or other equity incentives to service providers.
When you decide to grant stock options or other forms of equity compensation to service providers, we recommend you call us. We have seen many instances in which a mistake is made in administering a stock option plan, and the mistake results in a lot more time and expense incurred than wanted or needed if we had been used to administer the plan in the first place.
Here is a list of things you will need to consider when you grant options:
First, the Board has to approve all option grants. If you do not have the Board properly approve option grants, this can cause problems down the road when the option exercise price has increased, and you have to go back and document approvals. Options are not considered “granted” until the Board has correctly approved them, not just the number of shares underlying the options but also other essential terms of the options such as the vesting schedule and exercise price. This can be achieved either pursuant to a fully executed unanimous written consent of the Board or at a properly noticed and duly called meetings of the Board which is minuted properly. It is generally easier to approve things via written consent if all the directors are in agreement.
Second, you must remain in compliance with state and federal securities laws. There are a number of technical legal requirements when you grant options, which include, but are not limited to:
- Possible filings with state securities agencies (e.g., California).
- Compliance with Rule 701’s mathematical limitations.
- Not granting options under Rule 701 to entities (we see this mistake made frequently). You can only grant options to individuals under Rule 701.
- Issuing the wrong type of option to independent contractors (you can grant ISOs only to employees).
Third, you must make sure your operating documents and cap table are up to date and correct and that they allow for the option grant. For example, your company’s equity incentive plan only allows for a certain number of options to be granted. Another example is that stock options are treated differently from stock awards on your cap table.
Fourth, board approval is the first step of granting stock options, not the only step. You still need to give your service providers a copy of the stock option agreement and a copy of the company’s up-to-date stock option plan to review and sign. These documents would govern the stock options and provide more details to the service providers about the terms of the stock options, such as how long the service providers can exercise the vested options, how they can exercise the vested options and, whether they need to pay any withholding to the company besides the exercise price.
In summary, because of what is at stake, we recommend you use us to help you administer your plan.
We have written several guides about how to administer your options for a stock plan that you might find helpful, including: (i) Stock Option Grant Checklist (https://www.startuplawblog.com/2010/11/01/stock-option-grant-checklist/); (ii) Stock Exercise Checklist (https://www.startuplawblog.com/2013/03/25/stock-option-exercise-checklist/) and (iii) a guide to stock option plan administration (https://thestartuplawblog.com/stock-option-plan-administration-guide/).
If you have any questions, please do not hesitate to contact me.
By: Haiyan Tao
Disclaimer: this post is for informational/educational purposes only. It is not intended to provide any legal advice.
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